Financial Derivative Case Studies

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Financial derivatives have crept into the nation 's popular economic vocabulary on a wave of recent publicity about serious financial losses suffered by municipal governments, well-known corporations, banks and mutual funds that had invested in these products. Congress has held hearings on derivatives and financial commentators have spoken at length on the topic.
Derivatives, however remain a type of financial instrument that few of us understand and fewer still fully appreciate, although many of us have invested indirectly in derivatives by purchasing mutual funds or participating in a pension plan whose underlying assets include derivative products.
In a way, derivatives are like electricity. Properly used, they can
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Counter party credit risk:
The risk that a party to a derivative contract will fail to perform on its obligation. Exposure to counterparty credit risk is determined by the cost of replacing a contract if a counterparty (as a party to a derivatives contract is known) were to default.
Legal risk:
The risk of loss because a contract is found not to be legally enforceable. Derivatives are legal contracts. Like any other contract, they require a legal infrastructure to provide for the resolution of conflicts and the enforcement of contract provisions.



Barings PLC was the oldest merchant bank in Great Britain. Founded in 1762. With total shareholder equity of £440 million, it was far from the largest or most important banking organization in Great Britain. Barings had long enjoyed a reputation as a conservatively run institution. But that reputation was shattered on February 24, 1995, when Peter Baring, the bank’s chairman, contacted the Bank of England to explain that a trader in the firm’s Singapore futures subsidiary had lost huge sums of money speculating on Nikkei-225 stock index futures and options. In the days that followed, investigators found that the bank’s total losses exceeded US$1 billion, a sum large enough to bankrupt the institution.


In 1992, Barings sent Nicholas Leeson, a clerk from its London office, to manage the back-office accounting and
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